By Jim Brunsden
Plans to require banks to hold extra capital during credit booms could limit growth, reducing the volatility of the global economy by up to 20 percent, according to a report published by the Bank for International Settlements.
Such buffers “could have a more sizable dampening effect on output volatility” than rules regulators set to govern the capital banks must hold at all times. Economic fluctuations could be reduced by up to 20 percent compared with a “baseline” scenario, the study published today said.
“This is a vital first step to allow regulators and the banking industry to understand the long term impact of Basel III,” said Irina Sinclair, a senior associate at law firm Allen & Overy.
A repeat of the excessive lending that fueled the financial crisis could be prevented using so-called counter-cyclical capital buffers, according to regulators. The buffers would be imposed on lenders when authorities determine a credit bubble is forming, and could then be drawn down to help lenders absorb losses after a market crash. Details of that plan were published by the Basel Committee on Banking Supervision in December.
“What’s important now is for the industry to test the assumptions and models which the study is based on if it is going to have the credibility everyone wants,” Sinclair said.
The Basel committee brings together authorities from 27 countries to coordinate capital and liquidity rules for banks and is part of the BIS structure.
Increasing the capital banks must hold at all times to protect themselves against insolvency will lead to a “long- term” reduction in economic growth, the BIS said. Each one percentage point increase in capital causes an average 0.09 percent decline in output, compared with the baseline, it said. The Basel committee agreed in September to more than double the core capital banks must retain.
The committee said in December that the capital rules would cut economic growth by as much as 0.22 percent over the eight- year period in which they will be implemented.